How to protect your retirement savings as interest rates rise

What does the Federal Reserve’s decision to raise interest rates mean for your long-term and retirement investments?

In the short term, there’s a chance for ongoing volatility in both the bond and stock markets. But as a retirement investor, you’re focused on the long term, right? And as a long-term investor, the key rule is: Don’t panic. That rule holds even for those in or near retirement.

That doesn’t mean it’s easy to ride out the volatility. But one strategy that can help is to focus on what you can control. Here are some steps to consider in light of the move toward higher interest rates:

1. Check up on your investments

This is a good time to review what you own as part of your retirement investment portfolio. People spend more than twice as much time doing research before a car purchase as they do picking their 401(k) investments, according to a 2014 survey conducted by Koski Research for Schwab Retirement Plan Services.

Do your investments still match your asset-allocation plan? (Do you even have an asset-allocation plan? If not, check out this introduction to asset allocation from the SEC.)

“Know what you own,” said Tripp Yates, a certified financial planner and wealth strategist at Waddell & Associates in Memphis, Tenn. “Figure out what your bond exposure is. Is it all Treasury bonds? Is it a mix?” he said. “You can make sure you’re diversified once you know what exposure you have.”

Given that Treasury bonds are the most interest-rate sensitive, he said, consider “having some corporate bonds, some global bonds, some short-term bonds — that’s what I mean by diversification on the bond side,” Yates said.

Others agreed. “Particularly in retirement, the bond portfolio is usually where you don’t want to take the risk,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research, speaking at a recent MarketWatch panel discussion on how to manage your retirement investments in a rising-interest-rate environment. Read the full special report here.

That means focusing your bond portfolio on “investment grade municipals, corporates, Treasuries,” she said. “Your bond portfolio — you want to keep it as safe as you can.”

Keep in mind that for investors in bond mutual funds, as rates rise, those mutual funds will be buying higher yielding issues; thus, while there may be some losses in the short term, investors with a long-term outlook can benefit.

Also, investors may need to embrace the idea of lower returns on bonds going forward. “I’ve talked to a number of people who are in retirement now who remember when rates were much, much higher,” Jones said. “They’ve been sitting in cash waiting for those rates to come back. They may not. Meanwhile, [those investors] have missed earning a lot of income in their portfolios. That can really add up over time if you stay in cash.”

2. Consider a bond ladder

One strategy to manage interest-rate risk is to invest in a bond ladder — that is, divide your fixed-income money among bonds with different maturities, such as one-year, three-year and five-year notes, etc. Each time one rung of your bond ladder hits its maturity, you simply roll over that money into the latest issue.

“We like bond ladders,” Jones said. “That’s a great way to take the timing out of your portfolio. You just have a ladder and you keep rolling it over. You can stop worrying about Janet Yellen.”

That strategy can protect people whether they’re invested in individual bonds or a bond mutual fund, Yates said. “Any bond manager today is most likely doing that ladder approach because that allows some of those bonds to mature at different times and the ability to take cash from the mature bond and buy the new bond that’s yielding at a higher interest rate,” Yates said.

3. Don’t try to time it

Trying to time bonds for interest-rate risk is like trying to time the stock market: you’ll probably get it wrong. While the Fed raised rates this week, that doesn’t necessarily mean the Fed will continue to raise rates, or, if they continue to raise, how fast they will do so.

“It’s not that rates are all of a sudden going to jump up,” Yates said. “We are in a very low-interest-rate environment by historical standards and will be probably for the next three years even if rates do rise,” Yates said.

This time next year, he said, “We’ll still be talking about rising interest rates, because we’ll be going at such a slow pace.”

4. Control your spending

When it comes to retirement savings, the key figure is how much you spend each year. The more you can control your spending, the easier it is to make your savings last.

“The most powerful lever you have is your spending rate,” wrote Rob Williams, director of income planning at Schwab Center for Financial Research, in a recent paper on how to maintain retirement income in a declining market.

Here’s an example from the Schwab paper: A person who retired in 2000 with $500,000 divided evenly between stocks and bonds, and who employed the 4% withdrawal rule (that is, take out 4% the first year, and the same amount in subsequent years, adjusted for inflation) would have ended up with $474,982 in 2015. But if that person had skipped the additional inflation adjustment in years when the value of the portfolio fell, he would have had $516,490 in 2015. In other words, a minor adjustment in spending yields an extra $41,508 in the portfolio.

5. The benefits of rising rates

Rising rates do signal some good news for retirement savers: savings vehicles such as certificates of deposit and bank savings accounts will start to offer higher yields.

“One thing that is really good is short-term interest rates will go up a little bit each time rates are raised so your CDs, your cash, those types of things: there’ll be a way to get more interest from your cash savings,” Yates said.

Still, given the outlook for slow interest-rate increases, it will take a while for those yields to get healthy. The national average rate on a one-year CD is currently just 0.27%, according to data compiled by Bankrate.com. (In 2008, a one-year CD offered more than 3%.) Still, even at today’s low rates, people who shop around are rewarded. The highest one-year CD yield right now is 1.33%, almost five times the national average, according to Bankrate.com.

Andrea
Coombes

Andrea Coombes is a personal-finance writer and editor in San Francisco. She's on Twitter @andreacoombes.

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